Best Practices for Reforming State Employee Pensions

September 19, 2012

Years of overly generous pension commitments to government employees have wreaked havoc on state budgets. Plans for reform have been thwarted by fierce opposition from government employee unions. While the Obama administration's stimulus plan helped alleviate some of the pressures on state governments to fund their pensions, now it is time to take a serious look at the problem and make adjustments, says Ivan Osorio, editorial director at the Competitive Enterprise Institute.

The outlook of pension funds is dire.

State and local unfunded pension liabilities nationwide are at least $1 trillion.

Furthermore, there will be a nationwide state budget shortfall of $757 billion.

Illinois, a state facing one of the more serious pension shortfalls, projects that the Teachers' Retirement System is likely to drop from 48.4 percent funded ratio to 18.8 percent.

In April 2011, a task force was created to identify the problems and potential solutions to states' budget problems. This year, the task force released its report, called the Racitch-Volcker report, and identified six structural factors that legislatures need to deal with:

First, pension payouts based on final-year pay. This prevents employees from "spiking," or racking up overtime pay in their final year to increase their pay-outs.

Second, collective bargaining. Unions provide a large amount of money to government elections to elect candidates that protect a union's interest. This effectively puts government employee unions on both sides of the bargaining table.

Third, binding arbitration. Unions and local governments submit binding arbitration to avoid strikes, but this proves costlier than strikes themselves.

Fourth, politicized pension fund boards. Board members make investment decisions that have political objectives unrelated to investment returns.

Finally, defined-benefit pensions. These guarantee benefits of a certain nature to retirees regardless of how the pension plan's investments fare. A defined-contribution pension like most companies have would allow benefits to fluctuate according to investment returns and wouldn't run the risk of runaway future liabilities.

In June, the GASB revealed new standards for accounting. The new standards are an effort to make it more difficult for managers of public pension plans to project unrealistic gains. Furthermore, the GASB standards will provide ammo against government employee unions because they can no longer point to optimistic numbers to support their desire to leave pensions untouched.